New default for Argentina won't be as bad as last default

By Sarah Marsh and Eliana Raszewski

6 Min Read

Argentina's Economy Minister Axel Kicillof announces what the government will do following a major setback in its long-running legal battle against "holdout" investors in Buenos Aires June 17, 2014.Enrique Marcarian

BUENOS AIRES (Reuters) - Argentina's battle with investors who rejected its proposals to restructure debt risks pushing the nation into a new default that would wreck its attempts to return to credit markets but not have the same economic effect as its catastrophic 2001-02 default.

The U.S. Supreme Court declined on Monday to hear Argentina's appeal against lower court rulings that ordered it to pay in full the hedge funds which refused 2005 and 2010 debt swaps on $100 billion in debt.

As the risk of default rises, Argentina must now either negotiate a deal with the funds it dismisses as "vultures" or quickly find a way around the court rulings that would prevent it from paying holders of its restructured debt if it doesn't also agree to pay the holdouts.

Argentina's battle with investors who rejected its proposals to restructure debt risks pushing the nation into a new default that would wreck its attempts to return to credit markets but not have the same economic effect as its catastrophic 2001-02 default.

The U.S. Supreme Court declined on Monday to hear Argentina's appeal against lower court rulings that ordered it to pay in full the hedge funds which refused 2005 and 2010 debt swaps on $100 billion in debt it issued in 2001.

As the risk of default rises, Argentina must now either negotiate a deal with the funds it dismisses as "vultures" or quickly find a way around the court rulings that would prevent it from paying holders of its restructured debt if it doesn't also agree to pay the holdouts.

Economy minister Axel Kicillof announced Tuesday the government is taking first steps to swap restructured debt to place it under Argentine law and make payments in Argentina. He also said he sent Argentine lawyers to talk to U.S. District Court Judge Thomas Griesa in New York about his ruling, as it's pushing the country into a default, even when Griesa said he doesn't want to do that.

Still, a new default won't likely bring on the same economic devastation the 2001-02 default did, policymakers and economists said.

"The economic situation was different," said Jorge Todesca, the deputy economy minister in 2002, noting that the economy had shrunk 10 percent over three years, the country had a trade deficit and "commodity prices were half of what they are now."

The state and banks were heavily indebted and industry had been battered by a decade of the peso pegged to the dollar.

At the end of 2001, thousands of Argentines lined up at banks to withdraw their savings, sensing the whole system was on the verge of bankruptcy. The country defaulted at the end of 2001, the currency crashed and the economy shrank 10.9 percent in 2002.

Now, while the economy is set to decline this year and inflation is high, the country has been growing at an average of 6.2 percent a year for a decade.

Banks are solid, with low capital ratios, and Argentina still boasts a trade surplus, albeit a shrinking one, thanks in large part to high prices for soy. It is the world's third biggest soybean and corn exporter, at a time of booming international food demand.

"This is not going to be a default because of a lack of capacity for payment, this will be a technical default because of the courts," said analyst Mauro Roca of Goldman Sachs.

SABOTAGE

Roca and other economists said a possible default might exacerbate the expected decline this year but not cause a meltdown.

Corporate and public credit would become even more expensive, uncertainty might put a further brake on already cautious consumption and investment, and the peso would come under more pressure.

Commodity exports would unlikely to be affected much, economists said.

Lack of access to capital markets wouldn’t be anything new: the country has been cut off from global capital markets for more than a decade. Foreign debt is lean, amounting to 8 percent of GDP in dollar terms, Kicillof said today.

A new default would, however, destroy Argentina's recent push to get back into international credit markets in view of its dwindling foreign reserves, which slid 30 percent last year.

Over recent months, the country has reached deals with Spain's Repsol and the Paris Club of creditor nations to regain international investors' trust, a strategy that helped lift stocks and bonds.

"This has come at completely the wrong time," said Neil Shearing at London-based Capital Economics, noting the driver of Argentina's economic weakness was strains with the balance of payments forcing the government to implement capital controls and devaluation.

"Had they been able to regain market access, they could have brought to an end this crisis in balance payments."

With little prospect of accessing markets any time soon and declining dollar reserves, the government might further tighten capital controls and import restrictions, former head of the central bank Aldo Pignanelli said.

Shearing said that access to capital markets and a few tweaks in policy like a tightening of fiscal spending could restore the economy to a situation of strength, unlike in 2001 when it needed a major overhaul.

"That's the infuriating point, Argentina is near and yet so far," he said.